Recently, I received an article by Alasdair Macleod, entitled “Economics of a Crash.” It’s an excellent overview of what’s to come over the next few years.

In reading the article, I was particularly taken by this reference:

…we can more easily imagine central bankers being drawn into repeating the mistaken policies of Rudolf Havenstein, president of Germany’s Reichsbank in 1921-1923. In predicting this final crisis for any country that treads down the path of government corruption of its money, the economist von Mises described its manifestation as a crack-up boom, the boom to end all booms, when ordinary people finally realise the worthlessness of government currency and dump it as rapidly as possible for anything they can get hold of.

Herr Havenstein is a forgotten man today, but he should not be. What he did as President of the Reichsbank in his day should not be forgotten, as the same conditions that existed in Germany back then are just around the bend once again.

With the coming market crash (what we’ve witnessed recently is just a preview of what’s yet to come), we shall see significant deflation. The central banks, particularly the U.S. Federal Reserve, have for years promised that if deflation rears its ugly head, as it did following the 1929 crash, they will not hesitate to print money unceasingly until the problem is solved. Money creation will be possible at a rate never before seen in history. In 1922-1923 Germany, it was necessary to physically print bank notes and distribute them. Today, all that’s necessary is to type credits into a computer. Billions can be created overnight.

When this money creation first occurs, there will be prominent support from the media that the central banks are doing what’s necessary to combat deflation. Everyone will support the idea, just as they did in Germany in the 1920s. Trouble is, it won’t work.

One reason deflation takes place is due to a fall in aggregate demand. An economic crash creates a fear of spending, resulting in lower prices for goods and services. A major crash creates major fear, one that’s unlikely to be overcome by increasing the money in circulation. People will praise the increase in money, whilst continuing to avoid major personal spending. They instead will focus their spending on necessities, such as food, fuel, clothing, etc. The less necessary an item is, the less likely there will be purchasers. As a result, the price of such items will fall.

Any asset that’s a luxury - boats, motorcycles, luxury homes, etc. will become difficult to unload, causing repeated drops in the asking prices over time.

Money creation will seem to be a good solution, as it suggests that people will have more of the stuff to spend, but overcoming the fear will take considerable money creation. And money creation has a habit of creating a greater increase in the prices of those goods that people are already focusing their spending on, like consumable commodities. Therefore, commodities will rise in price whilst assets will remain down.

Since the problem of deflation has not been solved, the central banks will do the only thing they know how to do, create even more money, which in turn creates more price increases in those commodities. Along the way, wages will need to rise to allow people to pay the new, higher prices but, historically, wages never keep pace when dramatic money creation is undertaken.

The net result is that the average individual will find it harder and harder to put food on the table and fuel in the car, and, in order to cope, will lower the asking price on the assets he’s still trying to unload, which of course signals the central banks that more money creation is needed.

Historically, this cycle never ends well, but how bad can it get? If we’re fortunate, the fear will be broken at some point by the creation of money. But before we heave a sigh of relief, it’s important to recognise that this happens rarely. And, to my knowledge, it has never happened in an instance in which the cause of the problem was insurmountable debt.

After World War I, under the Treaty of Versailles, the war’s victors forced Germany to accept a repayment burden for causing the war. The debt level, as it was assessed, was so great that it was virtually impossible to pay. The German people were taxed to a degree that made it difficult to afford necessities. They responded by offering for sale any assets they felt they could do without.

Enter Rudolf Havenstein, new President of the Reichsbank. Herr Havenstein set about the creation of more money and was widely praised for his action. This caused price increases in commodities, so he created more Papiermarks (the name for the German currency at the time) so that people could pay the increased prices. But the cycle described above kicked in. He then did the only thing he knew how to do, he kept printing.

Thus began “The Delirium of Milliards,” Milliard being a term for billions. Prices of goods and services rose more and more quickly, as more money was supplied. By mid-1923, hyperinflation was in full swing. Prices rose daily and workmen were paid several times a day to allow them to spend the money, to get rid of it, buying anything tangible, to avoid holding the rapidly inflating fiat currency. Even though bills were printed in ever-higher denominations, people eventually needed baskets, even wheelbarrows, of bank notes to pay for daily needs. Eventually, it took 200 Five Milliarden Mark notes like the one pictured above, issued in Berlin in 1923, to pay for a loaf of bread.
It’s important to recognise that Herr Havenstein received full support from everyone for his actions, the government, the war’s victors, the communist party, Hitler’s growing contingent, and the people themselves all supported the printing, as it was clearly the most immediate approach to the problem.

Unfortunately, just as more heroin is the most immediate approach to the problem of heroin addiction, the printing of Papiermarks was headed toward an overdose.

But, along the way, the hyperinflation created chaos throughout society. It brought out the worst in everyone, fear, greed, panic, class hatred, and corruption.

Farmers produced bumper crops, but were loath to accept Papiermarks for their goods. Storehouses were full, but people in cities starved. City-dwellers rode out to the farms on their bicycles in gangs, stealing food and killing farmers and any livestock that they couldn’t carry with them. Gluttony became a legally punishable offense. Unlimited fines were imposed upon anyone deemed to be hoarding.

Demands rose from many factions for a redistribution of wealth, each group thinking that the others should pay more. Transfer of funds was made illegal without government authorisation. All German capital abroad was confiscated. Social entitlements received diminished increases until the amounts being paid became worthless. The taxation system broke down. No one knew what to charge or what to pay.

New banknotes were being delivered daily in boxcar loads. In October 1923, banknote circulation amounted to 2,496,822,909,038,000,000 and everyone called for more.

It is this last fact that is most telling, that every group believed that the solution was simply more money. They failed to grasp that what was needed was to simply cease all manipulation of the system and let the free market return. Their failure assured that the only possible outcome was the collapse of the system.

And so, as crazy as the above seems, it’s likely to happen again, as human nature is the same today as in 1923. Whether the extreme of hyperinflation will occur, we can’t be sure. What is certain however, is that each of us should be prepared.

If you know the other and know yourself, you need not fear the result of a hundred battles.

Sun Tzu

We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.